What's behind the surprise oil cut?

FILE PHOTO: A section of the BP Eastern Trough Area Project oil platform is seen in the North Sea in Scotland

FILE PHOTO: A section of the BP Eastern Trough Area Project oil platform is seen in the North Sea in Scotland

Published Mar 7, 2017

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Singapore - The oil is light, sweet and tempting, with a

lot of it made in the US. Saudi Arabia’s trying to keep it away from the

biggest crude buyers.

The Middle East producer cut the pricing for some of its

April oil sales to Asia, surprising customers who were expecting an increase

that was signalled by the structure of the market. That shows it’s trying to

lure buyers toward its lighter and less sulphurous crude varieties at a time

when similar-quality grades are rushing to the region from the Americas, Europe

and Africa.

‘Sweet’ crudes with less sulphur are typically costlier

than dirtier ‘sour’ oils because they can be more easily processed into

valuable products such as gasoline. With its latest pricing, the premium of one

of Saudi Arabia’s lightest grades to its heaviest has shrunk to the smallest

since July 2015. This is the producer’s latest effort to defend sales in Asia

-- a region that’s already largely spared from its output curbs -- as Middle

East prices strengthen and make supply from elsewhere relatively cheaper.

“This came as a complete surprise to the market,” said

Tushar Tarun Bansal, director at industry consultant Ivy Global Energy in

Singapore, referring to the Saudi pricing cut. “This is a signal from the

Saudis that they are serious about market share and pricing crude

competitively, and would even be open to changing the methodology if the need

arises.”

The world’s biggest crude exporter cut the official

selling price for its Arab Light crude to Asia by 30 cents to 15 cents a barrel

below the regional benchmark for April. Refiners and traders had expected

state-run Saudi Arabian Oil Co. to set pricing at 30 cents more than the

marker. It was the first time in at least a year that the grade was set at a

discount when buyers were predicting a premium, data compiled by Bloomberg

show.

The company known as Saudi Aramco also cut April pricing

for Asia from a month earlier for Extra Light crude by 75 cents and Super Light

by 50 cents a barrel. The Medium grade was reduced by 30 cents while Arab Heavy

was left unchanged. In other regions, Heavy crude for the Mediterranean was the

only grade for which pricing was increased.

The bigger reductions for lighter varieties don’t mean

the company isn’t facing competition in sales of heavier grades. Some sour

supplies that have rarely or never-before come to Asia have recently been

flowing to the region, but are still relatively sporadic.

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Light, sweet crude, like that which is produced in

American shale fields and Europe’s North Sea, pose the bigger threat. While

Saudi Arabia leads output cuts as part of a deal between OPEC and other nations

to erode a global glut, supplies are ramping up in regions such as the U.S.

where producers aren’t part of the agreement. That’s boosted Middle East

benchmark Dubai crude relative to other markers such as US West Texas

Intermediate and Brent.

“The tightness in the crude market now is clearly in

medium and heavy sour grades, not in lights,” said Amrita Sen, chief oil

analyst at Energy Aspects in London. “Part of that is clearly to do with the US,

and rising US exports, much of which is headed to Asia in February.”

US WTI crude was 58 cents a barrel below the Dubai

benchmark on Monday after flipping to a discount in December for the first time

since at least May. Brent, the benchmark for more than half the world’s oil

including North Sea and West African supply, was $1.56 a barrel above the

Middle East marker, after the premium shrunk last month to the smallest in more

than a year.

West African producers last month were expected to send

the most crude to Asia in at least five years while unprecedented flows of

North Sea oil were bound east earlier this year. Eagle Ford shale and West

Texas Intermediate are among U.S. oils that have recently made their way to

Asia.

The flow of cargoes from the west meant there “were

competitive pressures,” Ivy Global’s Bansal said. “However, this has been a

case in the past but Saudis have always stuck to their pricing methodology.”

While the latest cut doesn’t mean the Middle East producer has completely moved

away from its traditional pricing method, “a change happening will not be seen

as impossible now,” he said.

Apart from its pricing strategy, Saudi Arabia has also

sought to defend market share via output tactics. In January, people with

knowledge of the matter said it’s continuing to pump lighter oil while

fulfilling its promise to cut output by focusing curbs on medium and heavy

varieties.

The Saudis are “facing more competition at the light

barrels side,” said Peter Lee, an analyst at BMI Research. “Because they’re

already cutting production from the medium to heavy barrels side, the Saudis

would hate to lose further market share in the light side of things.”

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